Cautious stance on long positions while we watch several of our shorts
In this morning’s Tematica Investing, which was later than expected to accommodate our Fed related commentary and include the removal of Philip Morris International ([stock_quote symbol=”PM”]) shares from the Tematic Select List, we recapped the outcome of the Fed’s March FOMC meeting, which, as expected, was a do nothing event when it came to interest rates. The one arguable surprise to some was the modest downgrade to the Fed’s GDP and inflation forecast for not only 2016, but also 2017 and 2018. With GDP “peaking” this year and inflation not expected to hit the Fed’s 2.0 percent target until late 2017 or 2018, it means the probability of fewer interest rate hikes than previously expected is even higher.
The stock market reception to the likelihood that “low to no” interest rates would be around longer than previously expected (as the Fed cut its expected number of interest rate hikes this year to 2 from 4 in December), led to the typical pop in the market. We’d note however, yesterday’s move was far more subdued than the past. We continue to be concerned about overly aggressive earnings expectations — given the persistent currency headwinds and the downward vector — and the slowing velocity of the global economy, particularly for the back half of 2016.With the increasing probability we will undergo a March quarter earnings season that at a minimum somewhat resembles the recent December quarter results that led to one of the worst starts to the new year in some time, we will continue to keep a defensive stance with our ProShares Short Dow30 ETF (DOG) and ProShares Short S&P 500 (SH) shares following the sharp rebound in the market over the last few weeks. We’ll also continue to stick with our “safer” Aging of the Population Health Care Select Sector SPDR ETF (XLV) and iShares Barclays 20+ Year Treasury Bond ETF (TLT).
From a shorter term, and therefore more trading oriented perspective, this means dividend paying stocks and more defensive sectors are likely to once again come back into vogue like they did when the market realized the Fed wasn’t going to raise rates as expected over the last 12 months. Simply put, more reasons to like our XLV shares.
Over the last few weeks the stock market has rallied back strong, which led to the S&P 500 finally closing above its 200-day moving average for the first time in months. At the same time a number of other indicators – RSI and the MACD in particular – point to the market nearing over bought levels. From a fundamental perspective, we reiterated our earnings expectation concerns above and when paired with that sharp rebound in the market, this raises the question of how much additional upside remains following the European Central Bank’s actions last week and the fallout from yesterday’s Fed meeting.
Even in cases where there are positive developments to aid a number of companies that have thematic tailwinds at their backs, the corresponding shares have rallied back significantly over the last month. As we look out at the drop in a number of different commodity prices other than oil, such as cotton, coffee, beef, pork and even chicken, the companies that are most likely to benefit from these drops have rallied back hard along with the market in recent weeks. Examples include shares of Cash Strapped Consumer company Hanes Brands (HBI), up 10.7 percent of the February lows; Rise and Fall of the Middle Class Starbucks (SBUX), up nearly 6 percent over the last month; Rise and Fall of the Middle Class Tyson Foods (TSN), up 8.5 percent; Scarce Resource company American Water Works (AWK), jumped 5.8 percent after being added to the S&P 500 index.
What this tells us is the risk-to-reward tradeoff, other wise known as the potential upside vs. potential downside, is more or less neutral. For the most part, not enough to go long and not enough to bet against the shares, more commonly referred to as going short or shorting them. In conditions such as this it warrants keeping our SH and DOG share positions intact for hedging purposes should market turbulence pick up with few demonstrative catalysts ahead in the near-term.
Continuing to Watch for a Short in Paccar Shares and Other Candidates
As we noted last week, there are instances where the potential downside to be had in a particular stock is approaching levels that warrant taking action. One such instance is the trucking industry, particularly the heavy truck industry, which is bumping up a number of challenges and headwinds when it comes to demand for new trucks this year. Despite the drop in February Industrial Production and the Fed’s modest downgrade to its economic outlook, shares of truck manufacturer Paccar (PCAR) inched their way higher, encroaching on the $55 level that we’ve identified as offering sufficient downside to warrant placing a SHORT call on the shares provided the fundamentals of the truck market remain as is or worsen further.
Yesterday, the American Association of Railroads reported its weekly rail traffic figures for the weekending Mar. 12th and year over year that figure for carloads and intermodal units fell 11.6 percent. This continues the string of weaker year over year rail car loadings and likely means that when reported, February and March truck tonnage data will be down year over year as well just like it was in January.
We will continue to be patient until there is sufficient downside to upside to justify putting an active short position on PCAR shares in the Tematica Pro Select List. We’ll continue to look for other short and put option candidates that have similar dynamics – eroding fundamentals, businesses that face substantial thematic headwinds and stretched valuations.
